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Although the agricultural markets have been in bear territory for several years and the prices of corn, wheat, and soybeans all stand near multiyear lows, the risk/reward outlook for a number of agricultural-related stocks appears quite positive.

In recent years, favorable weather conditions have kept crop yields and inventories high, putting pressure on commodity prices. In addition, advancements in seed technology from companies such as Monsanto and DowDuPont have led to a roughly 1% annual improvement in crop yields.1 Lower crop prices, in turn, have kept a lid on the prices of seeds, crop-protection chemicals, and fertilizers, with corresponding weakness in the stock prices of the companies making these items. Sentiment on the group has been negative for quite a while, and most stock valuation measures we follow are near the lower end of their long-term ranges.

With that said, long-term demand for various kinds of protein is in a projected uptrend (see first chart below), while the supply of arable land continues to fall (see second chart). This long-term agricultural supply-demand profile bodes well for crop prices, and potentially for the profitability and stock prices of certain companies. Further, although weather has been cooperative for farmers lately, all it takes is one disruptive weather event in one major growing region to make a significant dent in that year’s yields and send crop prices soaring. Due to the unpredictability of weather conditions and the fact that these markets can turn very quickly, there’s often little time to build a position if an investor waits until conditions are favorable.

Demand for protein-based food has been increasing around the world and is expected to increase going forward

E = estimated consumption. *Represents developing countries excluding least developed countries as defined by OECD. The category "other" includes sugar, vegetable oil, eggs, roots, and tubers. Sugar and vegetable oil represent negligible shares of total protein consumption. Vegetables, fruits, pulses, and other food items are not included in this figure. Source: Organization for Economic Co-operation and Development (OECD), Dec. 31, 2015.

Another long-term positive factor, in my view, is that major industry players appear to be bullish. This is evident in the number of large mergers and acquisitions that have occurred lately. In the seed and crop-protection chemicals categories, we’ve seen a merger between Dow Chemical and DuPont—which closed at the end of August—as well as the announced acquisition of Monsanto by Germany-based Bayer that is expected to close in early 2018. Elsewhere, Potash Corporation of Saskatchewan is planning to join with Agrium, combining two Canada-based makers of fertilizer. This deal is expected to close in the next few months.

The world’s supply of land that could be used for farming has been declining over time.

Source: World Bank, as of December 31, 2014.

China has also been an active buyer of ag-related companies. Over the summer, state-owned ChemChina finalized its purchase of Syngenta, a Swiss maker of pesticides and seeds. The $44 billion deal was China’s biggest foreign takeover of all time. Around the same time, Dow Chemical announced that an agriculture fund backed by the Chinese government would pay $1.1 billion for its Brazilian corn seed and research business. Overall, Chinese firms have spent $91 billion over the past decade purchasing nearly 300 foreign companies involved in agriculture, chemicals, and food, according to deal-tracking firm Dealogic. The acquisitions are part of the nation’s plan to improve its ability to feed its population of nearly 1.4 billion.2

Given these developments, I remain optimistic that the investment prospects for higher-quality agricultural-related stocks over the next several years are quite compelling.

Rick Malnight is a portfolio manager and research analyst for Fidelity Investments. Mr. Malnight, who joined Fidelity in 2007, is responsible for managing multiple portfolios focused on the materials sectors.

Definition: M1 is a measure of the most liquid portions of a country’s money supply.

Index Definitions: The CRB BLS Spot Market Price Index tracks 22 commodities presumed to be among the first influenced by changes in economic conditions. The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates.

Views expressed are as of December 1, 2017, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

Past performance is no guarantee of future results.

Investing involves risk, including risk of loss.

References to specific investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.

This piece may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.

Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.

Materials industries can be significantly affected by the level and volatility of commodity prices, the exchange value of the dollar, import controls, worldwide competition, liability for environmental damage, depletion of resources, and mandated expenditures for safety and pollution control.

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